Slide 1



Slide 1

In this module the accounting equation is re-introduce and expanded it to include revenue and expenses.

Slide 2

Remember the accounting equation in topic 2 and how it forms the foundation of the Balance Sheet? Let us expand the accounting equation to include revenues and expenses. Notice that we have broken down Stockholder’s Equity or Owners’ Equity into Capital or Common Stock and Retained Earnings.

Retained Earnings, as discussed in topic 2, are simply retained or saved income or profits. And…Net income is simply Revenue minus Expenses. So…to increase retained earnings we add revenue. To reduce retained earnings we subtract expenses.

Slide 3

Now pull up ACCTEQUATIONworksheet.xls. You might find it easier to print a hardcopy of this worksheet and write in as we go over each transactions.

The first transaction is “investment of $10,000 cash by stockholders”. Analyzing this transaction in terms of the accounting equation we increase cash $10,000 and increase Common Stock $10,000. Notice that both sides of the equation equal each other so it balances.

The second transaction is “note issued in exchange for $5,000 cash”. Once again using the accounting equation we see that cash increases $5,000 and the notes payable increases $5,000. Equation equals.

The third transaction is “purchased $5,600 worth of office equipment for cash”. Using the accounting equation we DECREASE or subtract $5,600 cash and increase PPE $5,600.

The fourth transaction is “services rendered for $11,200 cash”. In this transaction we increase cash by $11,200 and we increase retained earnings $11,200. Remember from the previous slide that revenues increase retained earnings.

The fifth transaction is “payment of $4,000 for employee salaries”. Cash is decreased by $4,000 and retained earnings are decreased by $4,000. Remember from the previous slide that expenses decrease retained earnings.

In the sixth transaction no money has changed hands. Thus there is no transaction to analyze. This is only a discussion with a customer.

For the seventh transaction we “purchased $8,000 in inventory on account” or in other words we purchased inventory on credit. We essentially promise to pay the $8,000 at a future date. Thus we increase inventory $8,000 and increase accounts payable by $8,000. The equation balances.

The final transaction we “make payment of $5,000 on the inventory we purchased on account in #7”. Cash is decreased $5,000 and accounts payable is decreased by $5,000. In this transaction we reduced our obligation to pay $8,000 at a future date by $5,000. We now only owe $3,000.

Slide 4

Please access ACCTEQUATIONsolution.xls for the solution to problem in slide 2

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